While duration matching may be beneficial for preserving the yield after a gap-year swap, the cash flow pattern of the newly issued gap-year TIPS will be quite different than planned out when the original ladder was established (if the coupon is different than the bracket-year temporary holdings). Since Kevin is focused on preserving the annual real amount received in every single rung, that introduces a bunch of additional constraints that may be difficult to meet. It would be simpler to just make the swaps at, or soon after, the auction (or whenever convenient) and accept the cash flows given by whatever the newly issued coupon rates might be.Sorry again, your logic just does not make sense to me. I might try to put together a spreadsheet, but a better option would be for you to have a conversation with a bond trader or an interest rate swap specialist. Bond duration matching in a hyper-efficient market should work perfectly, whether the bonds in question are newly issued or not. Any swap trader worth his salt could tell you this.The upshot of all of this is that duration matching to cover the gap years does not work like it would if the gap years were somehow priced as if they were trading on the secondary market, in case it would work excellently, as I've shown. I have not yet come up with a mathematical analysis that shows that it does work--quite the contrary, the more I experiment, the more it appears that duration matching, as described early in this thread, does not work as I, and I think many of us, had assumed.What I'm looking for is mathematical proof of any statement like this. So far, I'm not seeing it.You are concerned about a situation where a high yielding TIPS at auction doesn’t provide enough principal amount to allow the maturity year ARA to approximate DARA. If that’s the case, then the prior year coupons reinvested should be sufficient to make up the difference. You can sell off portions of the prior year TIPS accordingly, which should get you to the same result of ARA close to DARA.
That’s a simple calculation that should work on your spreadsheet. If not, why not?
Consider the following simple thought experiments:
If TIPS at auction are "different" why not just wait a week or so for the newly auctioned gap year TIPS to trade on the secondary market? That would solve your problem immediately.
If "auction pricing does not work like secondary market pricing" and there really was a difference in how TIPS are priced at auction and how they are priced while traded it would be a huge arbitrage opportunity. The fact is there is no such arbitrage opportunity.
At least that is what I have been doing. I have no firm idea of what my cash flow needs might be in the future, so some raggedness (lack of smoothness) in the payouts of each rung doesn’t bother me.
Statistics: Posted by MtnBiker — Thu Jun 20, 2024 7:51 pm